Decade-Defining Brands: OPEC

Thanks to the worldwide recession, OPEC warns of a “devastating contraction” in demand for oil and falling prices.

It may cut production in an effort to boost prices, or at least to prevent a sharp drop, but OPEC’s warning underscores a basic point: Even a cartel providing the key commodity to the world’s economy can’t escape market forces.

But not for lack of trying - or lack of prior success. OPEC defined the 1970s with an embargo that nearly quadrupled the price of oil and created long lines at gas stations. So, how did it acquire all that power?

Unlike coffee or chocolate, there's no substitute for oil, making it the ideal product for a cartel.

OPEC, short for the Organization of Petroleum Exporting Countries, is best known for the 1973 embargo the sent the price of a barrel of oil to about $11.65 from $3. Thanks to the embargo, the US economy shrank by about 6% a year for 2 years.

Early in the 20th Century, oil producing countries lacked exploration technology and production skills, leaving them unable to challenge Exxon (XOM), Shell (RDS.A), British Petroleum (BP), Gulf, Texaco, Mobil and Chevron (CVX) -- then known as the "seven sisters" -- on price. But in 1943, Venezuela signed the first 50-50 deal with the oil companies that called for an even split of profits on top of a royalty. Saudi Arabia quickly demanded  -- and got -- a similar deal.

The US had been a net exporter of oil until about 1948 when domestic producers could no longer compete with cheap foreign supply. In 1959, British Petroleum single-handedly cut crude oil prices about 10%, raising howls from the producing countries. In August 1960, a second price cut was announced, and in September Iran, Iraq, Kuwait, Saudi Arabia and Venezuela responded by forming OPEC in an effort to gain some control over pricing.

Initially, OPEC succeeded in halting a decline in prices, but was unable to significantly boost them. One reason: Cartel members have incentive to cheat by boosting production.

The incentive to cheat generally results in the breakup of a cartel, but OPEC remained intact, in part, because its portion of the world’s production rose to about 41% in 1970 from 28% in 1960.

Few Americans paid any attention to OPEC until the Israel-Egypt war in October 1973. Saudi Arabia refused to boost output to counter rising prices unless the US backed the Arab world. The US refused. When President Nixon proposed a $2.2 billion million aid package for Israel, Arab states halted oil shipments to the US.